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Thursday, 2 May 2013

Reinhart and Rogoff - Battered but not beaten

Like boxer who has
taken a pounding Reinhart and Rogoff, the Harvard economics duo, have donned
the dark glasses and have been responding to their critics. They strongly contest that their research was
slipshod and that their Excel skills are childlike, but the accusations that
they doctored the figures to suit their point of view just won’t go away.

To remind you they
published a paper “Growth in a Time of Debt,” in May 2010 that asserted they
had empirical evidence to show that once the debt to GDP ratio exceeded 90% any
country would hit the wall and crumble to economic dust. Unfortunately for these high minded scholars
a number of intellectually challenged politicians appropriated they idea
as justification to embark on a path of austerity, and we all know where that
has got us.

The rebuttal of
their opponents claims is becoming
increasingly laughable and technical – ‘we
included both median and average estimates for growth, at various levels of
debt in relation to economic output, going back to 1800. Our paper gave
significant weight to the median estimates, precisely because they reduce the
problem posed by data outliers, a constant source of concern when doing
archival research that reaches far back into economic history spanning several
periods of war and economic crises’.
To summarize their defence – “ours
(median) is much smaller than yours (University of Massachusetts)” – not a
great boast I think you will agree!

There are two
things going on here that are important.
The first is that virtually all economists are trying to over simplify a
very complex world. Any rational person
knows that as the level of debt increasing the likelihood of a default will also
rise. But what is also painfully obvious
that the sustainable level of indebtedness with vary dependent on interest
rates, growth rates, currency valuation, balance of trade, etc. Of-course all of these are interconnected but
to postulate that there is a definitive tipping point is both dim witted and annoying. The second point of importance is that government
debt is only one piece in the jigsaw puzzle, as we know to our cost private
debt and bank solvency are just as important.
A country with public debt at 90% of GDP with solvent banks and strong private
deposits may well be in better shape than a country with lower public debt but
high private debt and insolvent banks.

Perhaps the most
irritating thing of all is that the spat arising from this mistaken and badly executed
‘research’ is giving the Keynesian left an opportunity the raise their tattered
flag. Many bankers and politicians who
should know better are now using this statistical cock-up to puncture the arguments
for fiscal prudence.

There is no doubt
that, despite this fiasco Reinhart and Rogoff are brilliant economists, but
sadly their best and most interesting ideas around ‘allowing financial institutions to be restructured through accelerated
bankruptcy,.” And their plea that – “First
and foremost, governments must be prepared to write down debts rather than
continuing to absorb them” shine a light on the real issue. Economic
growth depends upon the desire to make money being
stronger than the desire to hold on to money,
not earth shattering but true. In 2008 the Western world was shattered economically and is now hanging on for grim death, since 2009 it has used
negative interest rates as its life line. In normal conditions low interest rates should stimulate economic activity but when there is a preponderance of distressed debt, low interest rates have the opposite effect, encouraging a lock down of private capital (Zombie businesses and Zombie Householders).

It is true that any indebted person, society or economy
who's survival is dependent on reducing the value of money to a negative real
number must be consigning themselves to an unending period of stagnation. The evidence for this is all around us, Japan
has ‘survived’ with very high levels of debt (up to 200% of GDP) because interest
rates have been negative for years. In ‘surviving’
they have avoided some pain but they are still terminally ill and have no
prospect for recovery. Some say that
monetarist are sadistic and that they just want to inflict pain for the sake of
it is to misconstrue the nature of things.
Humans contest and compete (read Darwin) and its clear that without the
natural clearing out of the unproductive and noncompetitive parts of our economy
(public and private) the whole is doomed to a slow but quite painless
decline.